Quantitative Problems Chapter 12 - University of Colorado ...



Quantitative Problems Chapter 12

1. Compute the required monthly payment on a $80,000 30-year, fixed-rate mortgage with a nominal interest rate of 5.80%. How much of the payment goes toward principal and interest during the first year?

Solution: The monthly mortgage payment is computed as:

N ’ 360; I ’ 5.8/12; PV ’ 80,000; FV ’ 0

Compute PMT; PMT ’ $469.40

The amortization schedule is as follows:

|Month |Beginning |Payment |Interest |Principal |Ending |

| |Balance | |Paid |Paid |Balance |

|1 |$80,000 |$469.40 |$386.67 |$82.74 |$79,917.26 |

|2 |$79,917.26 |$469.40 |$386.27 |$83.14 |$79,834.13 |

|3 |$79,834.13 |$469.40 |$385.86 |$83.54 |$79,750.59 |

|4 |$79,750.59 |$469.40 |$385.46 |$83.94 |$79,666.65 |

|5 |$79,666.65 |$469.40 |$385.06 |$84.35 |$79,582.30 |

|6 |$79,582.30 |$469.40 |$384.65 |$84.75 |$79,497.55 |

|7 |$79,497.55 |$469.40 |$384.24 |$85.16 |$79,412.38 |

|8 |$79,412.38 |$469.40 |$383.83 |$85.58 |$79,326.81 |

|9 |$79,326.81 |$469.40 |$383.41 |$85.99 |$79,240.82 |

|10 |$79,240.82 |$469.40 |$383.00 |$86.41 |$79,154.41 |

|11 |$79,154.41 |$469.40 |$382.58 |$86.82 |$79,067.59 |

|12 |$79,067.59 |$469.40 |$382.16 |$87.24 |$78,980.35 |

|Total | |$5,632.83 |$4,613.18 |$1,019.65 | |

2. Compute the face value of a 30-year, fixed-rate mortgage with a monthly payment of $1,100, assuming a nominal interest rate of 9%. If the mortgage requires 5% down, what is maximum house price?

Solution: The PV of the payments is:

N ’ 360; I ’ 9/12; PV ’ 1100; FV ’ 0

Compute PV; PV ’ 136,710

The maximum house price is 136,710/0.95 ’ $143,905

3. Consider a 30-year, fixed-rate mortgage for $100,000 at a nominal rate of 9%. If the borrower wants to payoff the remaining balance on the mortgage after making the 12th payment, what is the remaining balance on the mortgage?

Solution: The monthly mortgage payment is computed as:

N ’ 360; I ’ 9/12; PV ’ 100,000; FV ’ 0

Compute PMT; PMT ’ $804.62

The amortization schedule is as follows:

|Month |Beginning |Payment |Interest |Principal |Ending |

| |Balance | |Paid |Paid |Balance |

|1 |$100,000 |$804.62 |$750.00 |$54.62 |$99,945.38 |

|2 |$99,945.38 |$804.62 |$749.59 |$55.03 |$99,890.35 |

|3 |$99,890.35 |$804.62 |$749.18 |$55.44 |$99,834.91 |

|4 |$99,834.91 |$804.62 |$748.76 |$55.86 |$99,779.05 |

|5 |$99,779.05 |$804.62 |$748.34 |$56.28 |$99,722.77 |

|6 |$99,722.77 |$804.62 |$747.92 |$56.70 |$99,666.07 |

|7 |$99,666.07 |$804.62 |$747.50 |$57.12 |$99,608.95 |

|8 |$99,608.95 |$804.62 |$747.07 |$57.55 |$99,551.40 |

|9 |$99,551.40 |$804.62 |$746.64 |$57.98 |$99,493.41 |

|10 |$99,493.41 |$804.62 |$746.20 |$58.42 |$99,434.99 |

|11 |$99,434.99 |$804.62 |$745.76 |$58.86 |$99,376.13 |

|12 |$99,376.13 |$804.62 |$745.32 |$59.30 |$99,316.84 |

Just after making the 12th payment, the borrower must pay $99,317 to payoff the loan.

4. Consider a 30-year, fixed-rate mortgage for $100,000 at a nominal rate of 9%. If the borrower pays an additional $100 with each payment, how fast with the mortgage payoff?

Solution: The monthly mortgage payment is computed as:

N ’ 360; I ’ 9/12; PV ’ 100,000; FV ’ 0

Compute PMT; PMT ’ $804.62

The borrower is sending in $904.62 each month. To determine when the loan will be retired:

PMT ’ 904.62; I ’ 9/12; PV ’ 100,000; FV ’ 0

Compute N; N ’ 237, or after 19.75 years.

5. Consider a 30-year, fixed-rate mortgage for $100,000 at a nominal rate of 9%. A S&L issues this mortgage on April 1 and retains the mortgage in its portfolio. However, by April 2, mortgage rates have increased to a 9.5% nominal rate. By how much has the value of the mortgage fallen?

Solution: The monthly mortgage payment is computed as:

N ’ 360; I ’ 9/12; PV ’ 100,000; FV ’ 0

Compute PMT; PMT ’ $804.62

In a 9.5% market, the mortgage is worth:

N ’ 360; I ’ 9.5/12; PMT ’ $804.62; FV ’ 0

Compute PV; PV ’ $95,691.10

The value of the mortgage has fallen by about $4,300, or 4.3%

6. Consider a 30-year, fixed-rate mortgage for $100,000 at a nominal rate of 9%. What is the duration of the loan? If interest rates increase to 9.5% immediately after the mortgage is made, how much is the loan worth to the lender?

Solution: The monthly mortgage payment is computed as:

N ’ 360; I ’ 9/12; PV ’ 100,000; FV ’ 0

Compute PMT; PMT ’ $804.62

The duration calculation is exactly the same as those done in previous chapters. However, there are 360 payments to consider. Using a spreadsheet package, the duration can be calculated as 108 months, or roughly 9 years.

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From the interest rate change, the value of the mortgage has dropped by over 4.1%.

7. Consider a 5-year balloon loan for $100,000. The bank requires a monthly payment equal to that of

a 30-year fixed-rate loan with a nominal annual rate of 5.5%. How much will the borrower owe when the balloon payment is due?

Solution: The required payment is computed as:

N ’ 360; I ’ 5.5/12; PV ’ 100,000; FV ’ 0

Compute PMT; PMT ’ $567.79

The amortization schedule is as follows:

|Month |Beginning |Payment |Interest |Principal |

| |Balance | |Paid |Paid |

|Option 1 |$100,000 |6.75% |30-yr fixed |none |

|Option 2 |$150,000 |6.25% |30-yr fixed |1 |

|Option 3 |$125,000 |6.0% |30-yr fixed |2 |

What is the effective annual rate for each option?

Solution: Option 1: (1 + 0.0675/12)12 − 1 ’ 0.069628

Option 2: First, compute the effective monthly rate based on the points as follows:

N ’ 360, I/Y ’ 6.25/12, PV ’ 150,000, compute PMT ’ 923.58

PMT ’ −923.58, N ’ 360, PV ’ 148,500, compute I/Y ’ 0.528789

Based on this, (1 + 0.00528789)12 − 1 ’ 0.065333

Option 3: First, compute the effective monthly rate based on the points as follows:

N ’ 360, I/Y ’ 6/12, PV ’ 125,000, compute PMT ’ 749.44

PMT ’ 749.44, N ’ 360, PV ’ 122,500, compute I/Y ’ 0.515792

(1 + 0.00515792)12 − 1 ’ 0.063681

11. Two mortgage options are available: a 15-year fixed-rate loan at 6% with no discount points, and a 15-year fixed-rate loan at 5.75% with 1 discount point. Assuming you will not pay off the loan early, which alternative is best for you? Assume a $100,000 mortgage.

Solution: Determine the effective annual rate for each alternative.

15-year fixed-rate loan at 6% with no discount points

(1 + 0.06/12)12 −1 ’ 0.061678

15-year fixed-rate loan at 5.75% with 1 discount point

N ’ 180; I ’ 5.75/12; PV ’ $100,000; FV ’ 0

Compute PMT; PMT ’ $830.41

PMT ’ 830.41; N ’ 180; PV ’ 99,000; FV ’ 0

Compute I; I ’ 0.4921841

(1 + 0.004921841)12 −1 ’ 0.060687

Based on these, you will pay a lower effective rate by paying points now.

12. Two mortgage options are available: a 30-year fixed-rate loan at 6% with no discount points, and a 30-year fixed-rate loan at 5.75% with 1 discount point. How long do you have to stay in the house for the mortgage with points to be a better option? Assume a $100,000 mortgage.

Solution: The two loans have the same effective rate at the point of indifference.

30-year fixed-rate loan at 6% with no discount points

This option has an effective monthly rate of 0.5%. Use this to back into N, as follows:

N ’ 360; PV ’ 99,000; FV ’ 0; I ’ 6/12

Compute PMT; PMT ’ 593.55

I ’ 5.75/12; PV ’ $100,000; FV ’ 0; PMT ’ 593.55

Compute N; N ’ 345

You will have to live in the house for more than 345 months (28.75 years) for the mortgage with points to be a cheaper option.

13. Two mortgage options are available: a 30-year fixed-rate loan at 6% with no discount points, and

a 30-year fixed-rate loan at 5.75% with points. If you are planning on living in the house for 12 years, what is the most you are willing to pay in points for the 5.75% mortgage? Assume a $100,000 mortgage.

Solution: 30-year fixed-rate loan at 6% with no discount points

This option has an effective monthly rate of 0.5%.

I ’ 6.0/12; PV ’ $100,000; FV ’ 0; N ’ 360

Compute PMT; PMT ’ 599.55

Use this to back into points, as follows:

I ’ 5.75/12; PV ’ $100,000; FV ’ 0; N ’ 360

Compute PMT; PMT ’ 583.57

The difference over 12 years is worth:

N ’ 244; FV ’ 0; I ’ 6/12; PMT ’ 599.55 − 583.57

Compute PV; PV ’ 2,249.65

If the points on the 5.75% loan are less than 2.249, the 5.75% mortgage is a cheaper option over the life of the loan.

14. A mortgage on a house worth $350,000 requires what down payment to avoid PMI insurance?

Solution: $350,000 ( 20% ’ $70,000. With this down payment, home owners are usually allowed to make their own property tax payments, instead of including it with their monthly mortgage payment.

15. Consider a shared-appreciation mortgage (SAM) on a $250,000 mortgage with yearly payments. Current market mortgage rates are high, running at 13%, 10% of which is annual inflation. Under the terms of the SAM, a 15-year mortgage is offered at 5%. After 15 years, the house must be sold, and the bank retains $400,000 of the sale price. If inflation remains at 10%, what are the cash flows to the bank? To the owner?

Solution: The discounted payment is calculated as:

I ’ 5; PV ’ $250,000; FV ’ 0; N ’ 15

Compute PMT; PMT ’ 24,085.57

The full payment is calculated as:

I ’ 13; PV ’ $250,000; FV ’ 0; N ’ 15

Compute PMT; PMT ’ 38,685.45

So, the bank is accepting a lower payment of $14,599.87 per year. In terms of dollars today, this is worth:

I ’ 13%; PMT ’ 14,599.87; N ’ 15; FV ’ 0

Compute PV; PV ’ 94,349.92

The expected house price is $250,000 ( (1.10)15 ’ 1,044,312

The owner will retain $644,312.

The bank will retain $400,000.

For offering the lower rate, the bank is earning a rate of:

N ’ 15; PV ’ 94,349.92; FV ’ 400,000, PMT ’ 0

Compute I; I ’ 10.11%, or slightly better than the rate of inflation.

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